Could The Bottom Fall Out Of This Oil Rally?

The oil markets will have to wait almost two more months before the uncertainty surrounding the pending OPEC deal is settled, so in the meantime a renewed focus on the fundamentals is in order.

The global oil production picture is still highly fluid, particularly with promises for a cut to OPEC production while some OPEC members (Nigeria, Libya, Iran) could actually ramp up output. But while output figures are more difficult to pin down, data on inventories is much clearer – and it still doesn’t look good for oil bulls.

As for crude oil inventories, they remain at extraordinary heights, despite having come down more recently. In the U.S., refineries are well into maintenance season, leading to a drop off in demand in September. Crude stocks are declining, but still remain high. For the week ending on September 23, U.S. oil inventories sat at 502.7 million barrels, which is up from 457.9 million barrels a year earlier. Softer demand from sidelined refineries could slow the drawdowns, leaving the U.S. very well supplied in the months ahead.

The landscape for refined products looks no better than crude oil. Inventories are extremely elevated, despite reasonably strong demand. In Europe, gasoline stocks in the Amsterdam-Rotterdam-Antwerp are more than a third higher than the five-year average. In the U.S., gasoline stocks have come down from their record highs seen earlier this year, but are still above the five-year average for this time of year. With summer driving season over, the sharpest drawdowns could also be behind us. For the week ending on September 23, gasoline inventories actually climbed by 2 million barrels, leaving them 6 percent higher than they were a year ago.

This comes despite strong demand from American motorists. Gasoline demand is up more than 4.5 percent from 2015 levels. But the buildup in products is just too high. "This year it is a big disappointment for gasoline -- demand is there, but stocks are just too high," a gasoline trading source told S&P Global Platts. The gasoline market has become "difficult to follow," the source added, as activity over the summer defied expectations.

On the refined products front, maintenance season is actually a positive thing. Fewer refineries churning out product means that margins will improve and stocks could come down. The flip side of that coin is weaker crude oil demand.

All in all, the elevated levels of oil and refined products sitting in storage will probably keep a lid on crude oil prices through the rest of this year and much of 2017. The IEA predicts that inventories won’t substantially come down until sometime next year. In its September Oil Market Report, the IEA revealed that total stocks of petroleum products in the OECD “smashed through the 3.1 billion barrel wall.”

The IEA warned about slowing demand, particularly in China, which could extend the oil price slump. In fact, China remains a very large question mark. The IEA said that China’s oil demand was “wobbling,” and indeed demand has slowed markedly as of late, hitting 10-month lows in July. But there is debate about what to expect next from China.

On the one hand, S&P Global Platts sees “brighter” days ahead for Chinese demand, which recovered by about 2 percent in August. "Demand in September and October will be better as harvest activity and the fishing season will increase demand for gasoil. The week-long National Day holiday in October will also stimulate gasoline demand as more traveling is expected," a refiner from Shandong said in an interview with S&P Global Platts.

On the other hand, China’s oil demand could drop off if it slows imports after filling up a big chunk of its strategic petroleum reserve. Oil demand was elevated earlier this year in part because of the rush to buy cheap oil and stockpile it into its strategic reserve. But with many storage tanks filling up, China might not need as much oil. JP Morgan predicts that Chinese oil demand could fall by about 15 percent.

Taken altogether, the oil market looks much the same as it did throughout 2016. Supply is still exceeding demand, inventories are still at exceptionally high levels, and demand is growing, but not fast enough to fix the imbalances. OPEC’s deal might have changed market sentiment, but the fundamentals do not look all that different than they did a few months ago.

The customers -- who would support higher prices if they could -- are still broke. Broke customers are why oil prices crashed beginning in 2014.

More will be broke tomorrow and even more the day(s) after. They are broke because they gain no return from their USE of the oil only from their willingness and ability to borrow, to plunge themselves further into debt.

It does not matter what the Saudis do, the frackers do; what the Chinese and the financiers and oil futures' traders do ... the customers are the only ones who matter and they are broke.